More than 18 months have passed since most registrants to the Securities and Exchange Commission (SEC) began adhering to new revenue recognition rules known as ASC 606, and the change took affect for private companies earlier this year. Meanwhile, the SEC has proposed changes to requirements related to M&A transactions and continued the debate surrounding disclosures related to a company's effect on the environment.
To find out how registrants are handling these complex issues, Toppan Merrill commissioned Mergermarket to speak with three leading experts on SEC disclosure policies for their insights.
Toppan Merrill question: The SEC has scrutinized the accounting of some companies under the new rule, and a number of them have been technology firms, such as Microsoft and Adobe. Do you think technology companies face particular difficulty with the new standard due to the nature of their businesses? As technology becomes more central to all businesses, how, if at all, do you think the SEC needs to adapt their disclosure rules to technology-derived revenue? Leading industry experts weigh in...
Andrea Basham, Cleary Gottlieb: I would agree that the new rule is probably most complicated for technology companies. To be clear, we definitely have some clients for whom there was little to no impact. But for tech companies, it's different, because the new standard forces companies to really determine who their customers are, and what the company's obligation is with respect to a deliverable or contracts with that customer. And if you think about tech companies – in fact it's not just tech but also professional service providers, where you have a contract that is meant to deliver certain types of services over time or that are contingent on certain implementation of software, for example – all the questions that are required to be answered in the accounting standard create a sort of road map.
In their communications with the SEC, a lot of the letters from tech companies explained how their accounting would play out if they determined that they entered into a contract to provide service at one particular point in time, and then they might "In terms of specific areas of focus by the SEC, the identification of what was going to be considered a performance obligation became an important issue.
With respect to the issue of investor relations in the context of these changes, we did not see a lot of confusion. Analysts understand this and changed their models accordingly, and I think companies were very careful to explain it in their disclosures.
Amisha Shrimanker Kotte, Jones Day: Based on certain technology company models, I think they certainly faced
"In terms of specific areas of focus by the SEC, the identification of what was going to be considered a performance obligation became an important issue."
Amisha Shrimanker Kotte, Jones Day
difficulty under the new standard. One of the biggest issues under discussion has been subscription-based services, because one aspect of these services is that you have returning customers, so they aren't completing a one-time transaction. Instead it’s a transaction that can evolve over time, or can be spread out over different kinds of contracts or subscriptions. So I think a number of companies faced challenges with trying to square that model with the new accounting standard.
For instance, if there was a customer who wanted to modify a service under one of their contracts, the modification may be considered a new contract at some point under the standard. For companies that implement software platforms, that process may only be considered fully delivered after certain steps are complete, which can change the timing of revenue recognition for them. The timeline of when performance obligations are considered to be fulfilled is critical, and that's where I think tech companies face an issue.
Going forward, as the technology market grows, we will need to think about how subscription-based and cloud services will need to report revenue.